Smartgroup Corporation Ltd (SIQ) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Smartgroup Half Year Results Briefing. [Operator Instructions] Please be advised that today's conference is being recorded. I would like to hand the conference over to your first speaker today, Tim Looi, CEO. Thank you, and please go ahead.

Good morning, everyone. Thank you for joining us on the call today. My name is Tim Looi and I'm the Managing Director and CEO of Smartgroup. Joining me on the call today is Nigel Underwood, our CFO. So Nigel and I will provide an overview of our financial performance for the 6 months of 30 June this year. Well, let's just take you through some key operational developments, we will then end the session with some questions. Now let's turn to the investor presentation. As shown on Slide 1, we report a half year profit result in line with the guidance provided at our June AGM. First, we delivered NPATA of $32.1 million. Our revenue was down 11% on the same time last year, with the revenues of April to June falling due to the impact of COVID-19 on the economic environment. Despite this, our business has remained robust and resilient and received no government assistance in the form of JobKeeper. Second, we have already completed over 90% of our top 20 client renewals for 2020. Total packages novated leases and fleet vehicles under management remains in line with December 2019. Third, we continue to simplify and improve our business operations with the retirement of selected platform as well as a restructure of our operational workforce. And finally, we have declared a final fully franked dividend of $0.17 per share based on a payout ratio of 70%, with net debt below 0.1x EBITDA of $12 million. Turning to Slide 2. We have summarized some of the financial and operational data for the half. The results clearly reflect the impact of the current COVID-19 environment on the business, particularly on the second quarter 2020. We will provide further insight on the relative performance of quarter 1 versus quarter 2 in later slides. Pleasingly, our salary packages, novated leases and fleet vehicles under management have remained relatively stable. The consequence of the operational restructure can be seen in the bottom table where full time equivalents fall from 703 in June 2019 to 617 in June 2020. We do however expect FTE numbers to increase in the coming months as we complete our operational restructure and recruit into vacant positions. Turning to Slide 3. You can see more details on our response to the new COVID-19-driven environment. We took prudent measures early on to protect our staff, preserve our customer engagement, contain our costs and ensure that our balance sheet remains strong. We also implemented an operational restructure to simplify the business and better serve our customers. As a consequence, a number of roles were made redundant as well as new roles created in areas that helped built the business. Overall, business meant a net reduction of 50 roles with an annualized savings of approximately $4 million pretax. The restructure also saw most temps, casual staff and contractors exiting the business. We will replace some of these roles with permanent staff over the next several months. Our focus was and continues to be on ensuring the well-being of our people and continuing to provide a high level of service to our customers. On Slide 4, you can see that our salary packages decreased slightly, with on-site activities effectively ceasing in early April. We have started to see some increased site access in South Australia and Western Australia as those communities reopen. We naturally continue to monitor ongoing developments closely, particularly in Victoria. Pleasingly, our service offering continues to resonate with the vast majority of our clients, and we have successfully completed more than 90% of our top 20 client renewals for the year. On Slide 5, it is important to reinforce that our client base is well diversified, with key end markets being the PBIs, hospitals, government and education, all attractive sectors within the Australian workforce. On Slide 6, you can see our novated leasing car park. It's decreased slightly for similar reasons as a reduction in salary packages. And on Slide 7, you can see the relative performance of our novated leasing volumes and yields between the quarters with H1 compared to pcp and private new vehicle sales. Our Q1 novated volumes and yields was slightly up on the same period in 2019 and continue to outperform the broader Australian private new car sales market. We saw a decline in novated volumes in Q2 and a higher level of customers refinancing their existing vehicles, resulting in reduced yields. On Slide 8, you can see that we continue to integrate and simplify our salary packaging platform footprint, with the retirement of the Selectus platform in June. Now turning to Slide 9. Credit approval rates for our customer base have remained relatively unchanged throughout the period. We also extended our contract with our major funder as well as establishing new relationships with 2 new additional funders. We continue to engage with Treasury and ASIC on potential reforms in relation to add-on insurance. Separate from the Treasury and ASIC reviews, the new supplier pricing for add-on insurance is effective from July 1, 2020. Applying the revised pricing to H1 volumes would have reduced after-tax profit by $2.3 million. We also took a noncash impairment charge against our investment in Health-e Workforce Solutions in the half. Health-e's contribution to our earnings has been negligible for some time. Now let me hand you over to Nigel, who will take you through the financial results in more detail.

Thank you, Tim, and good morning, everyone. Turning to Slide 11. Like many businesses in Australia, our financial results were impacted by the onset of COVID-19. In order to assist you to appreciate its impact, we have provided financial information by quarter as the impact of COVID-19 primarily occurred in late quarter 1. We do not plan to move to a quarterly reporting format going forward. COVID-19 had the greatest impact on our leasing business. This part of our business was trading at approximately 1% above quarter 1 2019 in both the revenue and volumes. Post the onset of COVID-19, quarter 2 2020 settlement volumes were 29% below quarter 2 2019. In addition, many customers whose leases were expiring over this period elected to refinance their lease rather than seek a new vehicle lease. Overhead costs have been reduced through a temporary reduction in wages as well as nonessential spend. We estimate these temporary savings amounted to $4 million in quarter 2 2020. Also in quarter 2 2020, we removed a net 50 role through an organizational restructure costing $1.5 million. The benefit of this restructure will amount to approximately $4 million in savings on an annualized basis. Since overall revenue or more specifically GST turnover did not decline the requisite 30% versus pcp, Smartgroup has not qualified for the federal government's JobKeeper subsidy. The last item to draw attention to is the write down in our joint venture investment in a Health-e Workforce Solutions. Smartgroup's 50% investment of $5.7 million has been reduced to $0.6 million. Health-e Workforce Solutions' contribution to Smartgroup's earnings is not material. The investment is now carried at net asset value. The write-down has been excluded from the NPATA calculation. The half year report provides more information on each of these discussion items. On Slide 12. Our primary measure of cash flow generation is to compare operating cash flow to NPATA. This measure adjusts for the noncash impact of amortization, an increase to 112% in the period due to some timing variances in receipts and payments. Typically, we expect a figure of around 100%. Turning to Slide 13. Smartgroup is a capital-light business, and this is demonstrated in the balance sheet. In March 2020, Smartgroup drew an additional $38 million from its debt facility to maximize liquidity. We also extended the facility to 2022. At June 30, net debt at $12 million is reduced from $22 million at December 2019. The impact of the write-down on Health-e Workforce Solutions investment is reflected in the other noncurrent assets line, while other lines have moved in line with business activity. Now I would like to hand over -- hand back to Tim for closing remarks.

Thank you, Nigel. So in summary, turning to Slide 15. Smartgroup delivered a half year NPATA of $32.1 million, in line with guidance provided. Our capital-light business model continues to generate strong cash flows, and coupled with a strong balance sheet, we're pleased to declare a fully franked interim dividend by $0.17 a share. Our focus in response to COVID-19 remains on safeguarding the well-being of our employees and continuing to provide a high level of service to our customers. Throughout this period, we continue to execute on our business simplification strategy with the retirement of another salary packaging platform as well as undertaking an operational restructure. Early performance in July saw an improvement in novated leasing volumes, together with a better mix of new vehicles compared to the refinancing of existing vehicles. However, the ongoing uncertainty associated with COVID-19 and the evolving situation in Victoria means that trading conditions will continue to be difficult and is not possible to give them any meaningful outlook at this time. I want to convey my appreciation to all our staff, the frontline team members, to people leaders and maintaining their focus on our customers and service. Their dedication, resilience and teamwork have enabled us to ensure that the business remain in a robust condition throughout this period of change and uncertainty. I remain confident that the strength of our people, customers and business model positions us well for the long-term success. That concludes our presentation, and I thank you for taking the time to join us this morning. Now allow me to hand back to Al and provide you with a chance to ask questions.

[Operator Instructions] Your first question comes from the line of Scott Murdoch from Morgans.

Tim and Nigel, just a couple from me. Just interested in the recovery in novated leasing that you've seen in June and July. Two things, if you can just talk to the activity across the various states that you're seeing? And also, if you can just give us some insight on what you would put down to your June, July performance recovery versus that of your major peer that we've also seen this week, just a bit of a difference there.

Thanks, Scott. I think it's fair to say that activity levels differ between states as the states have differing views on the freedom movement, certainly in WA and South Australia, our business is pretty much back to normal with the exception that we're not visiting certain sites, for example, HK. In relation to Q2 and July, right? July is 1 month, but we can -- I can certainly say that May was better than April. June was better than May, and July, right, was a little bit better than June, right? So it has been positive. But I do want to caution you that Victoria is obviously entering a different stage of the economic activity.

Okay. And just the second part of that question was just any insight that you would have. Your major peers sort of have seen a better than your numbers recovery in those months. And I know there's some -- just interested in what you see the differences in the business. I think, from my view, it's probably geographic. Is my understanding correct there?

Look, I think the -- look, we don't really want to comment on our competition. I mean, all I can say is that in relation to Victoria, right, I know that our exposure to Victoria is probably higher than this. So I'll leave it at that.

Okay. Just interested in your views on the latest asset proposal for deferred sales. Assuming that the current proposal is implemented, how you think you can fit that sort of required process into your sales process of add-on insurance sales?

Absolutely, Scott. So a couple of things. I think -- well, ASIC has been looking into this add-on insurances for a little while now. And we know that I gave a pretty fulsome update on the treasury process. And the treasury process is complete, legislation is expected to be adopted in December this year, right? Our business model, I think, can be adapted to fit into treasury proposal. The ASIC process remains very much in consultation. And I think recently, early August, they've released another submission asking for industry consultation. So we are continuing to engage in that consultation through our industry body right now, Scott. So I think as to what the outcome met with ASIC, I think we're consulting heavily through NPATA And I think we -- our business model, and certainly our leasing model, right, fits nicely with treasury. And that will be our focus for those discussions with ASIC.

Okay. Just last question before I pass it on. Just interested in the yield on leases. Obviously, we've seen the full EV detailed that for us. And I'm assuming most of that, if not all of it, is to do with the level of refinancing and the mix of sales. Just interested sort of like-for-like if there has been any yield degradation in that quarter or in the half and if there's any actual opportunities to increase the yield going forward.

Scott, it's Nigel here. The yield is -- key variant in the yield calculation is the mix of refis. So historically, we were looking at a 1 and 5 refinance mix. During COVID, it went to about 1 and 3. In July, it moved on to 1 and 4. So that will be a key driver of the yield going forward. The other thing you need to take into account, as we've kind of flagged is, we've got the reduction in yield because of the Eric Insurance price reduction. And so make sure you factor that in.

Our next question today comes from the line of Phillip Chippindale from Ord Minnett.

Just on Slide 7, just the volumes that you disclosed for the second quarter on novated are down 29% compared to new car sales down 25%. Just the first time, I think, from memory, that I've seen that number worse than the new car sales numbers. So can you just talk to why you think that is? Is it really just a function of the geographic mix that you referred to earlier in relation to Victoria? And then more specifically on Victoria, how much of your novated business comes out of that state?

Sure. Thanks, Phil. Yes, you're right. It's the first time for a little while that we've underperformed the new car sales market in a private channel. And a couple of things. I think Q2 wasn't impacted by Victoria because obviously, Victoria was like New South Wales. The underperformance, right, I think, comes down a couple of things. The first one was that as you look into June, and June traditionally has been a peak for the industry, right, and certainly for our business, too. As you look into June, I think, into the new car sales stat, you would have seen a lot of luxury vehicles being sold. Our customer base typically has -- buy new cars right in the region of between $30,000 and $35,000. So certainly not luxury. So I think we underperformed on that basis. The second one -- second thing is that, typically, in June, we see a lot of what we call walk up deals, right, where people call us and they want to settle on a deal fairly quickly because they've secured a car. We didn't see a lot of that -- a lot less anyway, right, compared to last year. And then secondly, in Victoria, our novated leasing, right, as a -- in relation to state -- on a state percentage basis, Victoria contributes between -- in the low 20%.

Okay. Can you just make a comment as to approval rates for novated leases? That's been a topic of discussion for a little while now. So just interested in your latest observations there, what you're seeing, the appetite from lenders? And how that sort of compares to maybe 12 months ago or comment of that nature would be useful as well.

Yes, sure. I think the -- we made a comment, I think, in one of the slides to say that approval rates haven't changed. I think a lot of that is to deal with the customer base within our segments that we operate in, being state government, health charities, right, so.

Okay. And then just finally for me. Just on the cost savings you implemented from short-term salary reductions, et cetera. When you've highlighted the cost savings from the restructure going forward, but I'm just wondering how much of your cost base, was there a benefit from those short-term changes that you made in the June quarter, et cetera?

Phil, the short-term cost savings were temporary, as noted and, they're based on the 1st of July.

Yes. I guess, I'm just wondering how much did your cost base decrease for that period?

Sorry. So $4 million for the period.

Sorry, I thought the $4 million was from the restructure on an annualized basis, and that just referred to the headcount changes, et cetera? Or is that including both that plus the cost reductions that you incurred on a temporary basis?

Phil, I might just chip in here. The restructure took a little while to occur. It took -- we started probably around mid-April, right, and really only completed in probably mid-June, so you wouldn't see a lot of that in half 1.

Your next question comes from the line of Tim Lawson from Macquarie.

Just a clarification on one of the earlier comments, I think, you made, Tim, around April, May was better than April, et cetera. That's versus pcp or a sequential comment?

It's sequential. I think versus pcp, for me anyway, right, during this time frame, pcp seems almost irrelevant, right? We're just looking at it from a month-to-month basis.

Yes. Okay. Got it. But July versus pcp?

I think, look, July, July versus pcp, look, I don't want to dwell on just 1 month, but July versus pcp was in line.

Yes. Okay. And you called out that $4 million impact from that Eric Insurance change is now with the mix and volume changes reduced to 2.3%. As volumes and I assume mix goes back away from that sort of as much as refinance as you've got during that second quarter, is there any reason to think that, that wouldn't be still $4 million if the volumes were the same? Or is there something else that's changed there that you're trying to identify?

I think a couple of things. I think firstly, I don't want to be presumptuous as to say what the crystal ball could be like. I know that July, right, for the 1 month, we saw an improvement in mix as to what ultimately ends up being the mix itself, I don't think we have any insight to comment at this stage. But certainly, July saw an improvement in mix, right, certainly from Q2.

So just to clarify, so let's say there's less refinance, and therefore, that product gets -- is more likely to get sold rather than you've introduced a different product into the mix?

Correct. That's right. That's right. As we sell more new vehicles, we're able to sell more add-on insurances.

Yes. Okay. And just around the temporary cost reduction. Just trying to understand, on the various parts of that, there's incentives, reduced spending, salaries, increased use of annual lease. But just trying to understand how those factors affect the cost base as volumes increase. So in that $4 million, for example, how would you have treated incentives that probably weren't going to get paid anyway on the volume reduction?

Okay. I think that the $4 million is not a theoretical calculation. If we had not temporarily ceased incentives, for example, we would have paid out a component of that. So those are actual real numbers that's calculated on the money that we had saved so.

Yes. Okay. And just with the savings in the annual lease, is there a high crossover with the people who have left the business in that? So I think that doesn't come back into a salary expense line?

I think the savings for annual lease is really more about optimizing our workforce during that period, rather than a monetary measure, right? So a lot of it was about making sure that people do take their leave during that time when we don't need them. So I think that was the main purpose of it. So I'd just say that 1st of July onwards, we're pretty much back to business normality, right, for our workforce and certainly for incentives and salaries and whatnot.

Yes. Okay. And just with the higher level of refinance experience, just trying to understand, there's obviously refinance experience historically as well. So where someone does push your contract for 12 to 24 months, what's the history tell you about what happens when we get to that sort of second sort of contract expiry point?

Yes. I think the -- this is what it looks like, right, Tim. At the end of your lease, right, you probably have between 1,200, 10,000 north of payout. And for some people, certainly during the COVID time frame, right, trying to then come up with that money or make a decision to pay out that lease, right? You make it with -- you compare it against, well, whether you'd like to push it out for another 12 months. And certainly, we saw a lot of our consumers deciding to do that. Now as to whether we're able to pick up that business when it comes time to refinance, we certainly hope so. A lot of it will depend on the economic environment and consumer confidence. So we'll see what happens in 12 and 24 months.

So with the benefit of the historical performance, do people tend to go into -- are more likely to go into a new car if they're extended a lease? Or are they more likely to pay the contract out and just leave your network effectively?

Look, I think our percentage of refis that we can -- so our percentage of continued customer engagement certainly has been high, around 50% or so. So of that 50%, right, some consumers will pick a new car, some consumers will extend that lease. So we're hoping to hold that percentage, right, going forward.

Yes. Okay. And just with the -- you obviously highlighted the higher cash position that you took throughout the period, and it seems, on the commentary, you've maintained that into 30 June. So just wondering, the thinking behind that going forward?

We'll probably evaluate that when conditions stabilize, and we can have a more thorough assessment of our liquidity requirements then.

We'll take our next question from the line of Chenny Wang from Morgan Stanley.

Most of them have been answered, but just to sort of dig a little bit deeper on yields. And I think you've touched on this a bit, but most of the impact sort of appear cyclical. And I was just sort of interested to see, whether there was anything more structural other than, I guess, other than insurance that we should be aware of?

Look, Chenny, I think you're right. Most of it is pending the mix. I think the attachment rate is for -- certainly for insurances, right, we saw a dip during the period due to consumer confidence. But apart from that, right, I think the only thing to think about is the Eric -- sorry, our insurance underwriter repricing, right, that's going to occur in half 2 -- that has occurred in half 2, sorry.

Cool. And then just on the novated recovery trajectory, and thanks for sort of providing the color there. I recall when you guys gave the AGM update that in June, you sort of see -- you sort of saw lease rebound but conversion rates were volatile. And I guess I was just sort of interested to see how that recovery into July and August has been, whether the trend has sort of been -- the recovery trend has been consistent? Or are those rates still bouncing around?

Yes. I think, certainly, if you look at it from a settlement perspective, Chenny, like I said before, right, April wasn't great, right? May was better. June was better than May, and certainly, July is better than June.

[Operator Instructions] Our next question comes from the line of Paul Buys from Credit Suisse.

Likewise, most of mine have been asked and answered, just a couple of quick ones. The first one, just you're being clear on the $4 million temporary cost savings coming back now. And also, obviously, you've implemented the $4 million of permanent cost saves. Just interested to get a bit more color on how you think of your cost base right now. I mean is it rightsized for the environment ahead? I mean, if conditions got a bit tougher, would you look at doing further permanent reductions? And have you got what you needed to kind of write-up recovery and potentially growth down track?

I think, Paul, as we mentioned earlier, at the moment, we're trying to fill some vacant positions that we've created over the last couple of months. So that's one thing we're going to do over the next couple of months. And certainly, the temporary and casual workers, right, that we had required historically, we're going to try and turn that into permanent roles. Certainly, a lot less permanent roles. And so that's what we're aiming to do. I think, certainly, from a cost base perspective, right, where we're sitting at the moment, we're fairly comfortable with it, that it reflects what we need to run the business. So I'll leave it at that.

Okay. And then last one, just some, I guess, plans across your peer group in terms of outstanding structures for novated leasing, just curious to know if you guys might have some of the plans on the horizon or something you've considered in that regard?

Paul, it's -- we're always looking at our funding. We've increased our panel of funders by 2 new providers in this period. It's something we always consider how we best to fund the business, but nothing on the table at the moment.

Our next question comes from the line of Tim Lawson from Macquarie.

So just a follow-up from me. In terms of the 90% you've called out on client renewals in the first half of '20 and obviously expecting to complete the rest in the second half. Just the level of competition, other terms and conditions getting rolled over, other people getting ahead of the panels, but just maybe some color around that comment, please.

I think the -- so the comment around renewals is this, Tim. We had renewed the majority of our 2020 renewals through the COVID period. We didn't meet our account manager face-to-face, right? It's all done over Zoom or in our case, Teams, right? So I think that speaks to the strength of the relationship that we have with our clients. That's the first point. The second point around client renewals, most of the contracts were renewed were pretty much in line with what we had historically, no very little changes in fees. The only one change is probably Victorian health client that we have renewed. That's a relatively small client, right, although it's a top 20, we saw a bit of the fees -- sorry, a bit of reduction in fees there.

[Operator Instructions] It appears there are no further questions at this time. I'd now like to hand the conference back to today's presenters. Please continue.

Thanks, Alara. Thank you, everyone, for your time and your interest in Smartgroup. I look forward to seeing you over the next coming days. Thank you very much.

Ladies and gentlemen, that does conclude today's conference call. Thank you for participating. You may now disconnect.